Dry January Boosts Scarcity Demand for Emerging-Market Junk Debt

(Bloomberg) -- January's issuance drought has increased the scarcity value of high-yield bonds, backing demand for new emerging-market debt.

Developing-nation debt sales declined by almost 40% last month compared with a year ago, and issuance of junk bonds fell 78% to $8.7 billion, making it the quietest January in six years, according to data compiled by Bloomberg.

With the equivalent of $104 billion of euro- and dollar-denominated non-investment grade debt set to mature in the rest of this year, yields near an 18-month high may entice junk-debt buyers flush with cash.

“Given that net issuance was negative year-to-date, we can see increased technical demand for new bonds,” said Kaan Nazli, a money manager at Neuberger Berman in The Hague. “We see technicals are supportive given higher and front-loaded cash flows, especially from higher-yielding names, and lower net issuance for the year.”

The issuance dearth may also attract investors to credits such as South Africa's Eskom Holdings SOC Ltd., the struggling electricity utility that's not generating enough cash to service its debt. “We see scarcity value in bonds like Eskom,” Citigroup Inc. analysts Alexander Rozhetskin and Eric Ollom wrote in a note to clients, adding that slowdown in new issuance should help narrow spreads.

Federal Reserve tightening expectations and potential sanctions on Russia caused a selloff in EM debt since August, but there are signs of calm returning to the market. The risk premium on high-yield sovereign and corporate debt from developing nations retreated 36 basis points in January, according to data compiled by Bloomberg. Outflows from emerging-market funds slowed to $276 million last week from $2.2 billion the previous week, Bank of America Merrill Lynch said, citing EPFR Global data.

Corporate debt from single-B rated Turkey and distressed sovereign debt of Ethiopia and Tunisia led January returns, while investment-grade bonds fell 3% as the tensions between Russia and the U.S. over Ukraine took their toll.

Waiting Game

“It is probably quite good that we had such a volatile month in January,” said Marion Le Morhedec, the Paris-based global head of fixed-income at Axa Investment Managers, which has $17 billion of EM debt under management. “A lot of investors are waiting to make their allocations and a volatile month will give more interesting opportunities to lock in the long-term yield.”

Borrowers and investors may be playing a waiting game as developing nations have to pay off a total $1.2 trillion-equivalent of debt in euros and dollars in the next three years. They'll have no option but come to the market to refinance even if this means paying higher rates.

“I am sure that if syndicate desks realize there is a supply issue, which means not enough issuance, they will try to increase supply of new issuance to the market,” said Max Wolman, a senior investment manager at Aberdeen Standard Investments in London. “The supply and demand imbalance won't last for very long.”